Restructuring Will Improve Operating Efficiency By 2025

Key Takeaways

• Strategic restructuring and innovative platforms like CORI and REGENETEN are enhancing revenue growth and operational efficiency, impacting margins positively as macroeconomic conditions stabilize.
  
• Advanced Wound Management and Sports Medicine segments' growth through innovation is expected to improve market share, product mix, and overall earnings.
  
• Challenges in China, pricing pressures, and reliance on innovation threaten revenue and margins, while macroeconomic headwinds and regulatory changes exacerbate risks.

Catalysts

Develops, manufactures, markets, and sells medical devices and services in the United Kingdom, the United States, and internationally.

• The 12-point plan initiatives are helping Smith & Nephew achieve consistent revenue growth above historical averages by improving product availability and executing successful commercial strategies, such as the development of new platforms like CORI and REGENETEN. This is expected to continue driving around 5% revenue growth and leveraging earnings.
  
• Significant margin expansion is anticipated from operating leverage and cost optimization within the manufacturing network, as macroeconomic headwinds ease and cost savings from previous restructuring begin benefiting the profit and loss statement. This is predicted to impact net margins positively, reaching between 19% and 20% by the end of 2025.
  
• The restructuring efforts, including the closure of four orthopaedics facilities and a 9% reduction in headcount, are forecast to contribute major cost savings and enhance the company's operating efficiency, which will directly contribute to profit margins and net earnings.
  
• Advanced Wound Management and Sports Medicine segments are set for robust growth underpinned by innovations like the GRAFIX PLUS and PICO platforms, aiming for additional market share and improved product mix. This focus will likely boost revenue and earnings across these business units.
  
• Continued improvement in cash generation and working capital efficiency is expected to support both profitability and free cash flow, surpassing $600 million in 2025, thereby strengthening the firm’s balance sheet and capacity to return value to shareholders through possible dividends or share buybacks.

Smith & Nephew Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Smith & Nephew's revenue will grow by 4.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 7.1% today to 13.0% in 3 years time.
• Analysts expect earnings to reach $868.6 million (and earnings per share of $0.99) by about May 2028, up from $412.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $961 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.5x on those 2028 earnings, down from 29.9x today. This future PE is lower than the current PE for the US Medical Equipment industry at 36.0x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.95%, as per the Simply Wall St company report.

Smith & Nephew Future Earnings Per Share Growth

Risks

• Continued challenges in the Chinese market, specifically with Orthopaedics and Sports Medicine due to volume-based procurement (VBP) and increased competition, pose risks to revenue growth and profitability.
  
• Persistent pricing pressure, with expected normalization after a temporary ability to pass on inflationary costs, may impact overall revenue growth and operating margins.
  
• The group is facing significant macroeconomic headwinds, including supply chain disruptions and inflationary pressures, which could dampen profitability despite cost-saving measures.
  
• High reliance on continuous innovation and new product launches for revenue growth brings execution risk and pressure on R&D investments, affecting operating leverage and net margins.
  
• Regulatory and market dynamics, such as anticipated VBP in arthroscopic enabling technologies, could further reduce revenues, particularly in China, affecting overall trading margins.

Valuation

• The analysts have a consensus price target of £12.121 for Smith & Nephew based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £13.98, and the most bearish reporting a price target of just £9.53.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $6.7 billion, earnings will come to $868.6 million, and it would be trading on a PE ratio of 20.5x, assuming you use a discount rate of 8.0%.
• Given the current share price of £10.54, the analyst price target of £12.12 is 13.0% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.